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 MOMENTOUS INVESTMENT APPROACH, WITHOUT THE CHARTS
 

   This is a translation of the former paper published by André Gosselin on the OrientationFinance.com web site on May 02 2004 ( Read the original paper in French here).

 

   Since the beginning of the bull market of the 1990s, the momentum approach has taken root among the classic investment styles, which are either based on the value of securities, or on company growthSince the beginning of the bull market of the 1990s, the momentum approach has taken root among the classic investment styles, which are either based on the value of securities, or on company growth.

 

   * Extract written by André Gosselin published in his book "Investir ŕ l’aide de l’analyse technique".

 

   Before the inlet of the computer science and electronic data bases about stock exchange activities, the only way of spotting securities that had known good returns compared to the market was to use technical analysis charts. The Internet growth now allows to use without expenses the search engines which sort and classify all the securities of a market according to the criteria of your choice. Among these criteria, there is, of course, the momentum of each security or, if you prefer, its return over the last 3, 6 or 12 months (the periods depend on the options offered by the security screener).

   For instance, security screeners like the Yahoo! Finances one or the Globeinvestor one make it possible to obtain instantaneously, without the use of any chart, a selection of the 10 or 20 securities which have enjoyed the strongest price growth over the last 6 or 12 months. With this information very valuable to technical analysts you can henceforth combine any factor suitable for the fundamental analysis. Thus, you could ask to screen out the 10 securities which have known the best price increase over the last 12 months, but only within the category of the securities which have a price/earnings ratio lower than 12.

   Investor who builds this kind of portfolio will be considered by the ones as a technical analyst and by the others as a fundamental analyst. However, it is neither one nor the other or, if you prefer, it is both at the same time, because it seeks securities which have a very good stock price momentum, but which, at the same time, constitute good bargains in the market. Thus, the security screeners available on Internet make it possible to have the best of the two worlds, i.e. to combine criteria of technical analysis with criteria of fundamental analysis. Better still, these new search engines enable you to be a systematic investor, because all the securities from one or several stock exchanges will be filtered by your grid in order to retain only the candidates which match the admission criteria.

   North-American investors are not yet aware of the revolutionary impact of these Internet research tools. They start gradually using these instruments, but without knowing exactly all the rigour and all the depth they can provide to their investment strategies. Moreover, I do not see a better way of investing than to marry the technical analysis with the fundamental analysis to thus extract the best of the two approaches and to obtain the maximum from it. The most serious and disciplined technical analysts study a hundred charts a day. Even if they think that they have a sufficient sample to apply their investment strategy, it is not the case. The Internet security screeners filter in a few seconds more than 5000 securities. There is no possible comparison, in this case, if your strategy includes 5 or 10 selection criteria. In such a case, there would not be enough of 100 technical analysts to reach a comparable result.

   Since the beginning of the bull market of the 90s, the momentum approach has taken a good place among the classical approaches based either on the value of the securities, or on the growth of the companies. As indicated by its name, the momentum approach bets on the securities which enjoy a strong uptrend. That means, for the ones, that it is necessary to buy the securities which have known the strongest appreciation of their stock price during the last months. For the others, the point is to buy the company securities which have known the strongest profit growth during the last three, four or five years. One can believe, at first sight, that there are two different schools inside the momentum approach. But I'm rather inclined to think that these are two distinct approaches which have taken the same label. Hence, confusion reigns here. Moreover, the approach known as earnings' momentum can be seen like one implementation of the growth seeker school, no more.

   These two strategies have in common that the securities which enjoy a strong price appreciation are often those which record a spectacular growth of their profits. However, investors who capitalize on the earnings' momentum do not explicitly seek the securities which have the most enriched their shareholders for the last year. They prefer to focus on the companies which declare profits higher than analysts' expectations or for which analysts upgrade their earnings forecasts.

   The approach which bets on the stock price momentum is in my opinion the most singular of both, because it has a rather original characteristic and a very precise objective: to find in the market the securities which have recently been broadly praised by the investors. Such securities can easily have generated returns of 100%, 200% or even 300% during the last 12 months. Of course, it is not the point to hope as much for the months to come, but simply to benefit from the trend and to know when to exit before it breaks.

   Before the inlet of Internet and electronic stock exchange data bases, the momentum approach was only reserved to technical analysis followers. Today, any investor can adopt a momentum approach, without to know anything about technical analysis. It is enough to have a micro-computer and to be connected to the Web.

   In spite of the major technological innovations that Internet brings, several psychological barriers slow down the interest of the individual investor towards the values which knew a very strong rise during the last months. The average investor behavior in front of values in full momentum is to believe that they are highly speculative securities or to think that these values have already generated their full potential of capital gain and that there is no more available margin for additional gain. The resistance is strong and the strategy will not suffer so early from an excess of popularity.

   However, the university research of these 10 last years is unanimous to recognize that the securities which knew the strongest appreciation of their stock exchange price in the last 6 to the 12 months tend to beat the market the next 6 to 12 months. This observation is valid as well for the European Community countries as for the Canada and the United States, no matter the size of the companies and the type of industries.

   Mark Hulbert, an analyst of the American financial letters and one of the well-known chroniclers of the Forbes magazine, observed that the financial letters which deliver the best returns for their subscribers have a strategy strongly centered on the momentum of the stock exchange prices. One can obviously quote the case of the Value Line letter, but it could also be added to the list letters like the MPT Review of Louis Navellier and OTC Insight of Jim Collins.

   James O' Shaughnessy, author of What Works on Wall Street and mutual fund manager, is one of the most active promoters of the investment strategies which are based on the stock exchange price momentum. Its strategy, applied in the Canadian markets, consists in buying the 25 or 50 Toronto Stock Exchange securities which have risen the most for last year. It renews the portfolio once a year, and it checks that the selected securities respect the three following criteria:

   1. Yearly earnings higher than last year.

   2. A price/sales per share ratio lower than 1,5.

   3. Sufficient volume to renew the portfolio in less than 20 days.

   All things considered, O' Shaughnessy makes a good mix of technical and fundamental analysis.

   An investor as James O' Shaughnessy only renews his portfolio once a year. Its strategy is simple, disciplined and requires from the investor only a few hours per year to manage his portfolio.



What Works On Wall Street


James P O' Shaughnessy

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   André Gosselin

 
 
 
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